Protectionism in Indonesia’s mining sector

In a recent survey released by the Canada-based Fraser Institute, Indonesia was ranked as the world’s least-attractive place to do business in the mining sector. And how to deal with foreign investors was the subject of intense debate in Indonesia last year after the government decided to make changes that required foreign miners to sell at least 51 per cent of their Indonesian operations to locals after operating for ten years. Previously they were obliged to sell only 20 per cent, albeit after five years. Other changes include a ban on the export of raw materials and requirements to move toward processing raw materials domestically by 2014.

The new regulations were issued under the 2009 Mining Law, which was meant to bring greater clarity into the sector. Foreign investors believe the law only creates more uncertainty and paves the way for greater economic nationalism. It makes provisions for the central, regional and provincial governments to issue licenses, which investors fear encourages turf wars between the different authorities; results in delayed approval of projects; and increases corruption. Standard & Poor’s warns that the latest rules will hurt Indonesian mining companies as well as international companies that have mining operations in Indonesia. Analysts and mining executives argue that ten years is insufficient to make an adequate return on their investments.

Indonesian businessmen and miners are circumspect in voicing their opinion. Apart from the mining sector, recent regulatory changes in the financial sector have also put pressure on foreign financial institutions. While a senior official from the Indonesian Mining Association agreed that the survey results were not surprising, there were no strong protests against the new changes. In fact, Indonesian tycoon Dato Sri Tahir told the BBC Indonesia needed to ensure its exports added greater value and that changes in regulations were necessary to ensure greater benefits for locals, particularly in the financial and natural resources sectors.

In general Indonesian businessmen are unwilling to decry protectionist changes despite understanding the necessity for foreign capital. Their reticence is due to growing economic and political nationalism in the country and discontent among communities affected by mining. The exploitation of natural resources by foreigners is not popular anywhere in the world, and in former colonial states like Indonesia foreign investment is a reminder of historical subjugation.

Officials at the Energy and Mineral Resources Ministry have fiercely defended the new rules and cite government measures to improve services and streamline approvals as evidence of larger reforms to encourage foreign miners to invest. The ministry says that ‘devolving’ the power to grant licenses to regional and provincial governments will lead to greater local participation and ensure Indonesia’s high growth rate is shared more equally. Indonesian academics support the requirement for greater value addition within the country as the country attempts to make its exports more competitive. It is in Indonesia’s interest to try and transform windfall gains from natural resources into higher levels of exports for long-term growth.

But policy makers must be careful not to push investors away. The mining sector makes up 12–17 per cent of GDP and almost 20 per cent of all foreign direct investment flows there. As much as 70 per cent of all investments in mining are backed by foreign capital. Without that investment the regional economies of many provinces would struggle to develop. A recent World Bank survey of companies making foreign investments revealed political risk to be of primary concern, with more than 50 per cent of respondents saying adverse regulatory changes top their list of concerns — well in front of classic ‘banana republic’ scenarios of civil war, coups and the expropriation of assets. Indonesia’s regulatory changes could scare away the investment it needs to develop its economy.

In the face of popular support for the new regulations and rising nationalism, politicians are likely to play to the galleries, at least until the elections, but they must ensure growth figures do not falter. The bureaucracy will not be much help: bureaucrats largely support the status quo and won’t oppose any policy that gives them more powers. Technocrats in favour of reform are in a clear minority.

Foreign investors will work through the new regulations for now, but policymakers have to be careful. Indonesia is emerging as an Asian success story, but any perception of rolling back on reforms, rising protectionism and regulatory uncertainty could mean disaster. Indonesia is also keen to play an increasing role in global and regional affairs and is committed to provisions of the WTO and regional trade agreements, including the ASEAN Free Trade Area and the ASEAN–China Free Trade Area. Indonesia must balance its right to take advantage of its resources with its responsibility to ensure economic growth.

Laldinkima Sailo is a Research Associate at the Institute of South Asian Studies, National University of Singapore.